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# Ch30 - Chapter 30 Exchange Up to now we have basically...

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Chapter 30 Exchange Up to now we have basically considered markets for a single good in iso- lation. Equilibrium in a single market was discussed to understand how demand and supply were affected by a particular good we were examining. This is called partial equilibrium analysis. In this chapter we begin the study of general equilibrium analysis: how demand and supply conditions interact in several markets to determine the price of many goods and services. We start by looking at an economy where people have fixed endowments of goods and examine how they might trade those goods themselves; no production will be involved - only pure exchange . 30.1 The Edgeworth Box The Edgeworth box can be used to analyze the exchange of two goods between two people. Assume two people A and B and two goods 1 and 2 in an economy. We can denote A’s consumption bundle as X A = ( x 1 A , x 2 A ), where x 1 A denotes A’s consumption of good 1 and x 1 A denotes A’s consumption of good 2. Similarly, B’s consumption bundle is denoted by X A = ( x 1 B , x 2 B ). A pair of consumption bundles, X A and X B , is called an allocation . An allocation 1

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2 CHAPTER 30. EXCHANGE is a feasible allocation if the total amount of each good consumed is equal to the total amount available: x 1 A + x 1 B = ω 1 A + ω 1 B x 2 A + x 2 B = ω 2 A + ω 2 B A particular feasible allocation that is of interest is the initial endow- ment allocation , ( ω 1 A , ω 2 A ) and ( ω 1 B , ω 2 B ), which is the endowment that the consumer starts with. They will exchange some if these goods with each other in the course of trade to end up at a final allocation . The Edgeworth box is shown below. Note that the width of the box measures the total amount of good 1 in the economy and the height mea- sures the total amount of good 2 in the economy. A’s and B’s origin are indicated in the bottom-left and top-right corners respectively. Indifference curves can be depicted in the usual manner.
30.2. TRADE 3 The Edgeworth box allows us to depict the possible consumption bun- dles for both consumers - the feasible allocations - and the preferences of both consumers., thereby giving us a complete description of the economi- cally relevant characteristics of the two consumers. 30.2 Trade Let us start with some original initial endowment of goods, denoted W in the figure above, and consider the indifference curves of A and B that pass through this point. The region where A is better off than at his or her endowment consists of all the bundles above her indifference curve through W. The same is true for B (but you need to look at the diagram upside down.) Clearly the intersection of these two regions represents the area where both A and B are better off. This is represented by the shaded lens-shaped region in Figure 30.1, where A and B would be better off, such as the point M.

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Ch30 - Chapter 30 Exchange Up to now we have basically...

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